Amendments to SFDR and their impact on asset managers

In December 2023, the European Supervisory Authorities (ESAs) amended the Regulatory Technical Standards (RTS) of the Sustainable Finance Disclosure Regulation (SFDR). The changes are expected to have significant implications with respect to disclosure requirements, transparency, and standardization. The move follows an April 2022 mandate from the European Commission (EC) and extensive stakeholder feedback gathered during a consultation held between April and July 2023.

The SFDR serves as a key pillar of the EU's sustainable finance agenda, which aims to standardize and increase transparency on the integration of environmental, social, and governance (ESG) factors into financial products to help investors make informed choices.

What has changed?

1. Changes to Principal Adverse Impact (PAI) indicators: The amendments introduced three new mandatory PAI indicators that focus on social aspects like human rights and labor standards, as well as several optional indicators. Moreover, the ESAs have made comprehensive changes to the existing social and environmental indicators, including revision to definitions, methodologies, and presentation, to enhance their scope and effectiveness. The following are a few examples of amendments to social indicators:

  • Addition of new indicators – 'Employees earning less than an adequate wage' and 'Exposure to companies active in the cultivation and production of tobacco'
  • Removal of the 'Interference in the formation of trade unions' indicator from the list of mandatory indicators; it has been renamed to 'Low coverage of collective bargaining agreements, and added to the list of opt-in indicators'
  • Change of wording of the 'Rate of recordable work-related injuries' indicator from injuries to accidents, to align it with current European Sustainability Reporting Standards (ESRS) terminology
  • Rephrasing the 'Breakdown of energy consumption by type of non-renewable sources of energy' indicator to 'the share of non-renewable energy consumption and production'

2. Amendments to PAI framework: The RTS document has been updated to reflect the following changes:

  • Revisions to PAI indicators, including new formulae, clarifications, and technical changes
  • Mandate for asset managers to consider the adverse impacts of investee companies' value chains when reporting PAI data (only if the companies themselves report on these aspects)

3. Stringent reporting on greenhouse gas (GHG) emissions: More stringent two-tiered disclosure requirement, based on accurate and detailed data collection, for funds with GHG emissions reduction targets to ensure transparency for investors.

Tier 1

  • Simplified summaries: Fund managers to provide pre-contractual documents and periodic reports to offer easily digestible info on
    • Target outcomes: What the product aims to achieve (e.g., environmental impact reduction)
    • Target ambition: How ambitious the goals are (e.g., alignment with 1.5°C warming limit)
    • Strategy effectiveness: How the investment approach contributes to achieving the goals
  • Periodic reporting: Asset managers to provide periodic reports that offer concise updates on progress, investment strategy's impact, and potential adjustments needed to achieve targets

Tier 2

  • Detailed information: Asset managers to provide a dedicated website with in-depth information and include cross-references to the website in pre-contractual and periodic reports

While the draft RTS offers flexibility on climate target approach to asset managers, it requires them to take concrete action to meet the mandated financed GHG emissions targets. The amendments mandate that asset managers have to outline their approach for the reduction of financed GHG emissions, which can be either via the divestment of high-emission assets, engagement with investee companies, portfolio reallocation, or investment in projects with emissions-reduction potential. The draft RTS also mandates that asset managers set product-level GHG targets, in alignment with the Corporate Sustainability Reporting Directive (CSRD), to reflect gross emissions within their investment portfolios.

4. DNSH test clarification: Asset managers to document methodologies and thresholds associated with PAI indicators on their websites and demonstrate the alignment of their sustainable investments with the Do No Significant Harm (DNSH) principle. The amendments aim to address the need for a more nuanced approach to the DNSH, which is aimed at aligning investments with the EU taxonomy.

5. Template simplification: The ESAs have reorganized the language and information structure of the financial product templates to eliminate redundancy and enhance clarity. A few changes are highlighted below

  • Key info dashboard: Asset managers to ensure that the first page of their dedicated dashboard highlights key details for easy access. Furthermore, the dashboard design should draw attention to crucial details, guide users, and reduce information overload. Detailed analyses to remain easily accessible within a document for sophisticated investors
  • Visual cues: Asset managers to implement easy-to-understand icons to indicate product nature (sustainable investments, alignment with EU taxonomy, PAI considerations, GHG emission-reduction targets, etc.)
  • Interactive access: Electronic disclosures to offer clickable links to dashboards that provide seamless access to detailed information

6. Disclosures for financial products with investment options: The updated SFDR Delegated Regulation recognizes the unique considerations of financial products with various investment choices. It includes specific provisions for pension products, which offer diverse choices such as the pan-European pension product. A few changes are highlighted below:

  • Pre-contractual disclosures: Products to include a dashboard that highlights the key sustainability info on each investment option that promotes or has a sustainable investment objective
  • Periodic disclosures: Asset managers to provide periodic disclosures after cross-referencing to the existing SFDR disclosures (e.g., website info) when a financial product offers many different investment choices
  • Website disclosures: Products promoting or having sustainable features or objectives to have a dashboard that summarizes relevant sustainability-related information for each product. Asset managers to provide additional details for each investment option and make them potentially accessible through cross-referencing

The amendments mandate that all underlying options, regardless of their individual SFDR classification (standalone product or not), must disclose their respective financial product templates. The wording within these templates should be adapted to accurately reflect the investment option instead of the product to ensure clarity.

7. Other technical changes

  • Calculation of sustainable investments of financial products: Financial products can choose between two methods for the calculation of their proportion of sustainable investments
    • Economic activity level: Economic activities contributing to specific objectives
    • Investment level: Focuses on entire companies directly invested in

Both methods consider the market value of investments as the denominator. Product disclosures must clarify the chosen calculation method.

  • Machine readability: Disclosures to be machine-readable (e.g., Inline XBRL) to facilitate analysis, comparison, and accessibility; this move aligns with future European Single Access Point requirements and sustainability reporting directives

For a deeper understanding of the impact of SFDR on asset managers, refer to The Impact of SFDR on Asset Managers: A Comprehensive Guide to Sustainable Finance Disclosure Regulation

Strategic opportunities for asset managers

The recent RTS updates can be a catalyst for asset managers to embrace transparency, enhance value propositions, and become leaders in the evolving sustainable finance landscape. Asset managers can

  • Gain a competitive edge: Standardized, clear, and accessible reporting formats build trust and attract investors seeking transparency in sustainable investing. This can provide a head start in capturing market share and establishing dominance in specific areas of sustainable investing.
  • Collaborate with ESG data providers: The amendments to SFDR will enable asset managers to collaborate with ESG data providers, rating agencies, and sustainability experts, thereby facilitating access to high-quality ESG data, improving data accuracy and consistency, and driving innovation in sustainable finance. Engaging with a wider ESG ecosystem will enable asset managers to enhance their ESG data capabilities and stay ahead of market trends.
  • Generate sustainable alpha potential: To cater to the growing demand for sustainable investments, asset managers can develop, and market investment products aligned with different sustainability objectives across asset classes, thereby generating alpha potential.
  • Risk-adjusted returns: A shift from basic screening and exclusion to incorporating robust ESG analysis into investment decision-making can lead asset managers to deepen their understanding of ESG risks and opportunities, and in turn empower them to identify risks, assess long-term viability, and make informed choices.

Challenges for asset managers

The evolving regulatory landscape of the SFDR continues to present new challenges for asset managers. While these developments aim to enhance transparency and promote sustainable investment, navigating the complexities can be strenuous. Some of the key hurdles for asset managers are highlighted below

  • Increased compliance burden: Expanding disclosure requirements and technical complexities will inevitably increase operational costs and workload for asset managers
  • Data availability and consistency: Sourcing reliable and consistent data on social and value chain impacts can be challenging for regions with less developed regulatory frameworks for sustainability reporting
  • Technology investments: Investments required for integrating machine-readable formats like Inline XBRL and adapting websites for enhanced disclosures can potentially pose challenges for some asset managers in difficult macroeconomic scenarios.
  • Understanding and complying with evolving regulations: Interpreting the updated RTS and ensuring accurate and complete disclosures can be complex, especially with potential overlaps with other sustainability regulations
  • Communicating complex information to investors: Presenting disclosures in a clear, concise, and engaging way for diverse investor audiences can be difficult
  • Integrating disclosures into existing workflows: Updating the disclosure processes smoothly without disrupting investment activities or client management can be challenging

How asset managers can adapt

Though changes to the SFDR may be strenuous and costly in the short term, they are expected to result in longer-term gains such as increased clarity and certainty of requirements, and resource efficiencies. To make the most of the available opportunities, asset managers can

  • Monitor and analyze regulatory changes and interpretations and adapt their sustainability strategies accordingly
  • Expand disclosures and details of investee companies in their reporting such as detailed reports on GHG emissions for funds with GHG reduction targets
  • Invest in technology solutions to streamline data management, analysis, and reporting
  • Implement robust internal controls and governance frameworks to manage ESG data and disclosures
  • Clearly communicate SFDR compliance efforts and ESG considerations to investors in accessible formats
  • Proactively engage with regulators, industry bodies, and other stakeholders to shape the future of sustainable finance
  • Ensure that their marketing materials accurately reflect their ESG practices and strategy and avoid greenwashing

By proactively addressing these areas, asset managers can not only navigate the evolving landscape but also position themselves for success amid the growing demand for sustainable investment solutions.

How Evalueserve can help

Evalueserve offers a comprehensive solution that combines AI-powered technology and deep domain expertise to assist asset managers in meeting SFDR compliance by simplifying ESG data requirements. We can help asset managers identify and manage ESG risks and opportunities, improve ESG data quality and transparency, and make informed investment decisions based on sustainability factors.

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Insightsfirst ESG Risk and Controversy Radar (proprietary AI-driven platform)

  • Identifies ESG risks and opportunities using AI / NLP-powered engines
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Knowledge solutions via domain experts

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Talk to One of Our Experts

Get in touch today to find out about how Evalueserve can help you improve your processes, making you better, faster and more efficient.  

Tamanna Nagpal
Manager, Asset and Wealth Management Posts

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